Last week we talked about cash flow issues that many service-based business face and where those issues often stem from. Today I’m going to address how to approach other cash flow issues that both service-based business and point-of-sale (POS) businesses face (i.e. retail stores, restaurants, etc).

SALES ≈ CASH

You might recall that for most service-based businesses, sales don’t equal cash. However, for POS-based businesses where you collect money up front, via either cash or credit, sales almost equal cash in most cases. Typically, the sales you generate will end up in your bank account one or two days later, in most cases. If this is the case, what could possibly be causing cash flow issues in your business? I'm getting there...

Not enough sales / Not selling enough

It’s true, your sales numbers might just not be cutting it. It could be because, at one time, you projected sales numbers, but your business isn’t actually hitting those numbers now. Or you may be discounting your offerings too heavily. The surefire way to test whether or not low sales are the problem is to build a sales breakeven analysis. More on that later. In the meantime, here are a few sales-to-costs KPIs (key performance indicators) you should be looking at on a regular basis:

Sales KPIs

Sales per square foot of space

Who for: Retail, restaurants, other POS-based businesses

Helps answer: Are we generating enough sales for our location?

Sales per employee

Who for: Tech, marketing, agencies, other service-based businesses

Helps answer: Are we overstaffed or understaffed? How effectively are we utilizing our people?

Sales per customer/user

Who for: Service- and POS-based businesses

Helps answer: How much of what we offer are our customers using/buying?

Your prices are too low

A lot of business owners I talk to think their pricing is spot on, but without having done any service / product costing. How much does it actually cost your business to deliver each product / service? Direct costs are important here (see Mike Albert’s article on why), but indirect costs are just as important. There is no doubt that the market often plays a role in pricing, but it’s more important understand what your prices and actual costs are for YOUR business. Otherwise, let’s just be honest – you’re just guessing. And guessing can be very a costly thing. I'm having a few of my clients go through this exercise right now.

Keeping too much inventory on hand

If you sell any sort of physical product (e.g. apparel, food, etc), you may be ordering too much of it. How quickly do you sell each of your products? Do you know how much inventory you should have on hand? In April? How about in January? Is there seasonality in your business that affects your customers’ behavior? When? By how much? By not accounting for these types of factors or tracking this data, you are just guessing. And as I've said before, guessing can be very costly. I just looked at a P&L a few days ago of a business that should have had a 25% profit margin for the month. Instead it was 7%. Can you guess why? Too much inventory was ordered. How much? 250% too much.

Some of your products don’t sell well

Don’t keep offering services or ordering products that don’t sell well. Selling well could mean, higher margin, lower quantity sold or lower margin, higher quality sold. You need to be tracking the products that sell well vs the ones that don’t. Holding on to products that don’t sell well – whether it’s a marketing package (yes, that can be a product), a handbag, or a cocktail on your bar's drink menu – will only help negatively affect your company’s cash position. It’s likely that it probably won’t drain your cash balance immediately. The bigger problem is that it will do it very slowly and then one day you’ll realize you have a massive problem that could have been avoided if you had stopped guessing.

You don't know how long your capital will last

So you’re a tech startup and you raised $1 million in funding? Moving into a nice office building? Going to hire a bunch of new employees? Good for you. What level of sales are those investments going to help generate? What are your costs going to be? Having capital and access to capital can be important. But what’s more important is understanding how long that money is going to last. When will you be at the point when your business is profitable (you're generating enough sales to be self-sustaining) and largely doesn’t need to rely on raising additional funds? Because if you don’t know, you’re just guessing. Stop doing that. I promise your investors won't like that.

You haven’t built up a cash reserve

Many times when I ask the question to business owners, “Have you built up a cash reserve?” They respond with, “What’s a cash reserve?” I’ll answer it here.

A cash reserve is an emergency fund for your business. You can use it for different purposes:

when sales fluctuate due to seasonality

when customer payments slow down

when you experience unexpected brief interruptions in business

when you have a large, unexpected expense

to pay partners’ quarterly distributions and taxes

to reserve for accrued bonuses

Every business should have an emergency fund. You have one for personal finances. Why not for business? Work to build up your business’ cash reserve to at least three months of operating expenses.

Your Expenses Are Too High

You could be generating enough sales, but your expenses could be out of whack. Begin by comparing expenses to sales. Start with your largest expenses. Among them are probably payroll and employee benefits, cost of goods sold (if applicable), rent, repairs and maintenance, insurance, advertising, and general and admin costs. If your variable expenses are too high, no matter how hard you work to increase sales, you may still end up with an unhealthy cash position. I talked with the owner of steel company doing $1.3 million in sales with a 30% profit margin and had a cash balance equal to about 10% of sales. Twelve months later, his company's running cash balance was barely able to cover a month's worth of payroll expenses. After I reviewed the company's books (prepared by a CPA), I found that the financial statements weren't even accurate.

HERE'S HOW YOU FIX THIS (IN 1 STEP):

If you've got the bandwidth, hire an outsourced CFO who can help you not only with cash flow, but also profitability, business performance, financial statement accuracy, and several other things that will help you do business better. A knowledgeable CFO will save you more money than you are paying them.

I cannot stress how important it is for every business to understand what their sales breakeven point is. I will write a separate post on how to determine your sales break-even point because there are a lot of things involved in the process. If you know how, don't forget to add back non-cash items like depreciation and include non-P&L items like debt service payments.

Check benchmarks for your industry (e.g. generally, payroll for restaurants should not exceed 35% of sales, payroll for creative agencies should not exceed 55% of sales) and compare them with your company’s performance.

Your sales breakeven point isn't where it ends. You need to see when cash comes in (cash inflow) and out (cash outflow) of your business. Here you'll be able to identify if your cash position is healthy and specifically what you'll need to improve if it isn't.

Step 4: Determine what the specific problems are and find solutions.

Are sales too low? Take this information to your sales team and build a goal around successful performance. Or hire someone to help you with sales. (Remember, whether you like it or not, every business has a sales team. I’ll talk more about this in a later post.) Are purchases for resale too high? Do a product price-cost analysis to determine if you’re pricing accurately. Are payroll costs too high? Analyze payroll costs by department, determine where there are inefficiencies, and work with managers to restructure.

Step 5: Monitor, monitor, monitor.

Never stop monitoring your business’ performance and financial health. After a baby is born, would it ever be a good idea to stop monitoring its health? Your business is your baby, and you should be the overprotective parent.

Step 6: Learn, adjust & improve.

As a business owner, you shouldn’t ever feel like can stop learning, adjusting, and improving. Take in the information from your sales break-even point, from your cash flow analysis, from your weekly or monthly KPIs, test things, evaluate what's working and what isn't, so you can do business better.

REALITY CHECK

You might be asking: Do I actually need to perform this sales break-even analysis and cash flow analysis to figure out why I’m having cash flow issues? The answer is: without a doubt. Need help with that? Start here.

This blog post is for service-based business that don't bill for services or products immediately or use a POS (point-of-sale) system. I will touch on cash flow for POS-based businesses in my next post.

SALES ≠ CASH

Sales (or revenue, depending on what you call it in your business) don't equal cash. There are multiple steps in between when you make a sale and when you actually receive the payment for your services.

Step 1: Invoicing | Sending the bill

Invoicing is the process of sending your customer a bill for the service you are providing. The first question to ask is: how quickly are we sending invoices out to our customers? Perhaps you're sending them out to customers weekly.

Step 2: Terms | When's the payment due?

Technically, terms are part of invoicing, but I've broken this step out because you may have terms that state that payment is not due immediately, but rather within 30 days of making the sale.

Step 3: Invoice Status | Have we been paid?

This is the step that businesses neglect most often. Sending out an invoice, doesn't guarantee you'll get paid within the terms. It's important to have a process in place where outstanding invoices are routinely followed up on so you can ensure timely collection of payment. Which leads me to my next point.

Step 4: Collection | Receiving payment

Sales don't equal cash until you actually receive payment.

SCENARIO: Let's map this out

You make a sale on May 5. Your company sends out invoices twice a month, every other Thursday. The invoice gets sent along with the next batch of invoices, which are processed on May 18 – the following Thursday. Most of your invoices are due in 30 days, so this invoice has a due date of June 17. June 17 is a Saturday and your customer is out of the office till Monday, June 19.

Your customer processes bill payments every Friday afternoon – the next bill pay date being June 23. Except on June 23, your customer's accountant was on vacation and doesn't process the payment until the following Friday, June 30. You receive the check in the mail on Tuesday, July 4. However, accounting only makes bank deposits on Fridays. On Friday, July 7 you make the deposit the check in the bank. On Monday, July 10, the check clears and the cash is available in the bank.

How many days did it take to receive cash?

From May 5 to July 10 is 66days. 66! So although the invoice may have stated 30 days terms, it actually took 66 days to receive the cash. And guess what? During that time, you incurred two months of normal operating costs (payroll, rent, insurance, etc) that call came out of your business bank account. Unsurprisingly, this is a very typical scenario for many businesses that receive payments via checks.

HOW TO FIX THIS (in 1 step):

Hire a outsourced CFO who can help you not only with cash flow, but also profitability, business performance, financial statement accuracy, and several other things that will help you do business better.

HOW TO FIX THIS (in 3 steps):

First, determine your Days Sales Outstanding (DSO).

There's a KPI (key performance indicator) called 'Days Sales Outstanding' that tells you the time it takes, on average, for you to collect on your sales. There a few ways to calculate this, but let's say that number is currently 55 days.

Second, review and make the appropriate changes to lower your DSO.

Review steps 1-4 (above) and determine where the problems are. Invoicing? Terms? Invoice Status? Collection? A combination? Make the appropriate changes to shorten the time it takes to collect cash.

Third, monitor this KPI every month.

Let's say you determine that your DSO should never be above 45. Then every month, when you review your company's DSO, if it exceeds 45, you'll know there was a problem that needs to be addressed.

MORE ON CASH FLOW

A lot of businesses operate without tracking various aspects of their financial performance. Cash flow is one of them. It's important to have the right strategies in place for your business so it can be successful, grow, and everything you dream it could be.

The DSO KPI can be different from business to business, depending industry, size, business model, or a host of other things. There are ways to increase cash flow by 2-3x using technology instead of checks. There are ways to automate processes instead of processing things manually. Reach out for help on how to improve cash flow in your business.

written by:

joe hamgeri

accountant / financial consultant

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